24 February 2011

Taxes and Entrepreneurship

I read an interesting article this week in Inc. magazine which suggests that there is no correlation between a country's tax environment and entrepreneurship. This theory runs counter to the common belief that profit incentives drive innovation and new enterprise. Isn't this the crux of capitalism - self-interest creates economic value?

Meet Norway - the exact opposite of the US. A country where there so many taxes that even Nancy Pelosi would say no: 50% on income, 3 times US payroll, 25% sales, and even a 1% "wealth tax" on total assets on people making more than $120k per year. Stifling for business, right? Apparantly not. Per capita, there are more entrepreneurs than there are stateside. The rate of startups exceeds the US and the gap continues to widen. Government programs seed startups in Norway because of its large coffers. And Norweigan entrepreneurs don't seem to mind paying the lion share of their profit to support the greater good.

There are many reasons why according to the article, but i'll discuss a couple relevant to this topic. For one, people don't worry about education, health care, and retirement. All bills paid by Uncle Sven. Think about the contrast in the US; most of us are tied to our corporate job specifically because of these things. We'll stay in suboptimal situations rather than launch a risky new venture where no health benefits exist for example. Also, entrepreneurs are not driven purely by money. They want to build businesses, their reputation, and make a mark on society. Sure money helps, but successful entrepreneurs have loftier goals in mind. Warren Buffett and Bill Gates didn't start businesses to make millions; it was the effect of them building great businesses.

Are we jeopardizing the long run for short-term wins? By not providing the necessities, are we incentivizing corporate drones at the expense of the next game changing industry? Is our money-centric culture preventing us from seeing the bigger picture of what business is designed to do (such as raise the standard of living for its residents)?

I'm not convinced that socialism is a business incubator at all. I think Norway has succeeded in spite of their tax code rather than because of it (due to factors such as its net exporter situation, small size, etc...). How many Googles or IBMs has Norway produced? The US simply has done it for a longer period of time and on a much greater scale than any other country in the world. And I do think free enterprise is the most efficient vehicle to change the world for the better. But it raises an interesting question, do we undermine the power of entrepreneurship by focusing only on the wallets of the entrepreneur ?

11 February 2011

The Innovator's Dilemma

With internet valuations back to the dizzying days of 1997, Huffington Post's sale to AOL this week for $315M actually seems reasonable. In justifying the deal to its audience, Arianna Huffington pointed to the "Innovators Dilemma" theory which states that large companies, no matter how successful, generally fail to adapt to the ever-changing business landscape and market trends. The primary reason stems from the fact that incumbents tend to focus on defensive tactics as they do not want to cannibalize existing sales by investing in areas that threaten their market position. In this case, AOL and HuffPost seek to change the face of news distribution by aggressively growing a free, open network-based media model where established players like WSJ or NYT, who are aggressively charging for access, will not.

In the internet age, its easy to see the Innovators Dilemma in play. Blockbuster filed for bankruptcy given the rise of Netflix and Redbox. Newspapers and magazines faced a quick, violent death. Bookstores and CD shops are no more thanks to e-commerce. Do you think all of these big companies failed to see the rise of the internet ? Its one thing for mom and pops to fail to adapt to the new Walmart in their locale given their limited resources, but how could Blockbuster not become the first streaming movie company? Did the handsomely paid executives miss what everyone else in the world saw ? Not at all. Their myopia handcuffed them from changing their distribution model, pricing, and cost structure. With quarterly pressure to prop up earnings, they failed to react to the bigger picture at hand. Instead of embracing change, they tried and failed to put up artificial borders around their existing business models. As they ultimately tried to cope, they were too little too late.

Long before the internet, this trend existed. American car companies almost went belly up (well 2 of the 3 did) with the Japanese invasion in the 1980s. Rather than focusing on fixing their business model, American Airlines tried to prevent Southwest from entering Dallas (but the Wright Amendment failed to stop Southwest from becoming the largest market-cap airliner). Macy's and other department stores, comfortable with their fat profit margins, failed to adapt to consumer's desire for lower priced apparel. Target was happy to oblige.

Its hard to blame the large companies from doing this. The emerging trend may not pan out. They might not execute as effectively as their competition. They are making good money, so why rock the boat? Thousands of reasons to look the other way and most of them justify it to themselves. This is why most innovation and true breakthroughs come from new players who have nothing to lose. So who's next? Cable television? PC companies like Dell ? Microsoft? Oil companies ? It's definitely an interesting question - one that will be answered by disruptive ideas and successful entrepreneurs.

What's ironic about HuffPost's argument for the deal is that AOL itself failed to adapt to the death of dial-up. It's easy to "reinvent" your business when its already in a downward spiral. I would have loved it if she was just honest and said "would you say no to $315M ?"